Delta Air Lines, struggling with high fuel costs, is considering a bid for ConocoPhillips' idled 185,000 barrel per day refinery in Trainer, Pennsylvania, according to a source familiar with the negotiations.
The board of Delta, the second largest US air carrier, has met twice to discuss a potential bid. It would be an audacious and unprecedented effort to hedge fuel costs for Delta, the world's largest commercial buyer of jet fuel, by taking control of a complex industrial operation in an industry that some major oil companies are abandoning.
It was not clear how or when a bid could be made, but Conoco last week extended its deadline for selling the plant by two months, until the end of May. CNBC reported that Delta could bid USD$100 million for the plant, which was idled last September due to depressed margins and weak demand.
A spokesperson for Delta declined to comment on a possible bid. A spokesman for ConocoPhillips said the company does not comment on market speculation.
"I can tell you that we are continuing efforts to seek a buyer for the Trainer Refinery," said Rich Johnson, a spokesman for the company.
In some respects Trainer would be a valuable asset. It is configured to produce a much higher yield of jet fuel than other plants, and accounts for a third of the total jet-kerosene capacity on the East Coast, according to government data. Delta is the largest international carrier at nearby JFK airport in New York, and jet fuel is nearly a third of an airline's costs.
But the refinery is also one of three in a 12-mile area near Philadelphia that have been pushed to the brink of closure by the high cost of imported crude feedstock and waning demand for gasoline and heating fuel, their main products. One of those, Sunoco's Philadelphia plant, will shut in July unless it finds a buyer; several bidders emerged this week.
Some analysts questioned why a company from a financially strapped sector would want to enter another precarious industry, one far from Delta's core operations.
"Even integrated oil companies have moved away from the downstream," said John Auers, of refinery consultancy Turner Mason, listing companies like Marathon, Hess, Murphy Oil and ConocoPhillips itself who have spun off or moved out of refining operations.
"Refining is a volatile business, a capital intensive business with a lot of uncertainty."
JET FUEL PRODUCERS
Delta spent USD$12 billion on jet fuel last year, with its average price rising by 31 percent to USD$3.06 a gallon. Last year, the company's aircraft consumed 3.86 billion gallons or just over 250,000 barrels per day (bpd) of jet fuel.
While many airlines use derivatives or even long-term physical deals in an effort to control their future jet fuel costs, buying a whole refinery would mark an extraordinary step to ease the pain of rising prices.
"It sounds like it's the ultimate hedge," said Ray Neidl, an analyst at Maxim Group.
Fuel is the largest expenditure for an airline at 30.7 percent of operating expenses. According to IATA, jet fuel prices were USD$3.32 a gallon or USD$139.30 a barrel at the end of March, up 2.9 percent from a year ago.
While simply owning a refinery would not protect Delta from rising crude oil prices, it could in theory allow it more control over its margins and supply chain.
"DAL is the world's largest commercial buyer of jet fuel, crack spreads are hard to hedge, and even if DAL can obtain a consistent USD$0.05/gal cost advantage over the long run, it's worth the risk," said Hunter Keay, an airline analyst with Wolfe Trahan.
Trainer has the capacity to produce over 23,300 bpd of jet fuel, nearly a third of the east coast's total capacity of 73,300 bpd, according to data from Energy Information Administration, the information arm of the Department of Energy.
Regional supplies have been tight since Trainer shut down at the end of September 2011. Data on Wednesday showed that production of jet fuel in the Northeast region, known as PADD 1, stood at 49,000 bpd last week, down from 72,000 bpd last year before Trainer was idled.
Ratings agency Fitch said that an onset of renewed industry margin pressure could ensue as jet fuels costs stay high and the air ravel demand outlook remains uncertain.
"Fitch Ratings sees persistently high fuel prices and potential difficulties in passing on rising costs through more fare hikes as the primary risks facing US carriers moving into the peak spring and summer demand period," the ratings agency said in a note.